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ECB’s Draghi Leaves Rate-Cut Door Ajar

European Central Bank cuts forecasts for 2013 growth, inflation.

The European Central Bank cut its economic and inflation forecasts and President Mario Draghi said weakness will persist into next year, leaving the door ajar for further interest-rate cuts.

“Weak activity is expected to extend into next year,” Draghi said today at a press conference in Frankfurt after policy makers left the benchmark rate at a record low of 0.75 percent. “Later in 2013, economic activity should gradually recover as global demand strengthens and our accommodative monetary-policy stance and significantly improved financial market confidence work their way through to the economy.”

While Italian and Spanish bond yields have plummeted since Draghi promised to do whatever it takes to save the euro and unveiled an unlimited bond-purchase program, the 17-nation currency bloc fell back into recession in the third quarter. The ECB’s latest forecasts paint a picture of economic stagnation and inflation falling well below its 2 percent limit. The euro fell more than half a cent to $1.3031 as Draghi spoke.

The ECB now forecasts the economy will shrink 0.5 percent this year, more than the 0.4 percent contraction it predicted in September. It cut its 2013 forecast to a contraction of 0.3 percent from 0.5 percent growth, and projected expansion of 1.2 percent in 2014. Risks to the outlook remain on the downside, Draghi said.

The ECB reduced its inflation forecast for 2013 to 1.6 percent from 1.9 percent and predicted a rate of 1.4 percent for 2014.

“Projections of undershooting inflation should keep rate-cut speculation underpinned,” Christoph Rieger, head of fixed- income strategy at Commerzbank AG in Frankfurt, wrote in a client note.

Euribor futures contracts rose, signaling investors are adding to bets for lower borrowing costs. The implied yields on the contract expiring in December 2013 fell five basis points, or 0.05 percentage point, to 0.17 percent at 2:05 p.m. in London.

The Bank of England today left its key interest rate at 0.5 percent and refrained from expanding its asset-purchase program.

Asked whether ECB policy makers considered a rate cut today, Draghi said they had a “wide discussion.” Still, he said the outlook for medium-term price stability “hasn’t changed substantially” and highlighted “some positive aspects of the current situation,” such as an increase in German business confidence.

Much ‘Already Done’

“We will continue to look at the situation, but to some extent we have already done much,” Draghi said. “If you think from July to today, some countries’ spreads, or some sovereign bond yields, went down by 200 to 250 basis points. That’s much more than anything you can achieve by a reduction in the short-term policy rate.”

German inflation fears may make policy makers think twice about cutting rates again.

Bundesbank President Jens Weidmann was the only member of the ECB’s Governing Council to vote against Draghi’s bond-purchase plan, known as Outright Monetary Transactions, saying it is tantamount to printing money to finance governments and warning of the risk that it could fuel inflation.

Draghi today reiterated that the ECB stands ready to activate the program as soon as a country like Spain fulfills the prerequisites of seeking aid from Europe’s bailout fund and signing up to conditions. He has also sought to placate German concerns with assurances that the purchases won’t fuel inflation.

“A rate cut could further undermine support of inflation-averse Germans and thus be counterproductive,” said Christian Schulz, senior economist at Berenberg Bank in London. “It is pivotal for the ECB to ensure strong OMT credibility. This means ensuring a maximum of support from Germany.”

The ECB today extended its policy of lending banks as much money as they request in refinancing operations through to at least July 9 next year.

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